Zoom Video Communications $ZM Q4 2023 Earnings Call

Thank you, Eric, and hello everyone. Let me start with a few of the financial highlights for FY23 and the results for Q4, and then provide our outlook for Q1 and FY24. We delivered solid results in FY23. Here were some of the highlights: our Enterprise business grew 24%, our non-GAAP operating margin was 35.9%, and we achieved a free cash flow margin of 27%. In Q4, total revenue came in at $1.118 billion, up 4% year-over-year and 6% in constant currency. This result was approximately $13 million above the high end of our guidance. The growth in revenue was primarily driven by strength in our Enterprise business, which grew 18% year-over-year and represented 57% of total revenue, up from 50% a year ago. We expect Enterprise customers to comprise an increasingly higher percentage of total revenue over time. From a product perspective, we had strong growth in Zoom Phone, coupled with contribution from Zoom Rooms and other products. Online average monthly churn decreased to 3.4% from 3.8% in Q4 of FY22, and increased slightly from 3.1% in Q3 as expected due to seasonality. The number of Enterprise customers grew 12% year-over-year to approximately 213,000. Our trailing 12-month net dollar expansion rate for Enterprise customers in Q4 came in at a healthy 115%. We saw 27% year-over-year growth in the upmarket as we ended the quarter with 3,471 customers contributing more than $100,000 in trailing 12 months revenue. These customers represent 28% of revenue, up from 23% in Q4 of FY22, and span diverse industries such as healthcare, education, government, and more. Our Americas revenue grew 10% year-over-year. EMEA continues to be impacted by the stronger dollar, macro headwinds, and online performance, which combined led to a decline of 9% year-over-year. APAC, also impacted by the stronger dollar, declined 5% year-over-year. Now, turning to expenses and margins. A quick note on our GAAP results in Q4: they included a one-time stock-based compensation expense of $208 million due to the sun setting of our supplemental grant program, which carries neither diluted nor tax deduction impacts. Moving on to our non-GAAP results, which exclude stock-based compensation expense and associated payroll taxes, acquisition-related expenses, net litigation settlements, net gains or losses on strategic investments, undistributed earnings attributable to participating securities, and all associated tax effects. Non-GAAP gross margin in Q4 was 79.8%, an improvement from 78.3% in Q4 of last year and 79.5% last quarter. The sequential improvement was mainly due to optimizing usage across the public cloud and our co-located data centers. For FY24, we expect non-GAAP gross margin to be approximately 79.5%. Research and development expense grew by 43% year-over-year to approximately $103 million. As a percentage of total revenue, R&D expense increased to 9.2% from 6.7% in Q4 of last year, reflecting our investments in expanding our product portfolio. Looking ahead, innovation will remain a top priority for Zoom. Sales and marketing expense grew by 20% year-over-year to $301 million. This represented approximately 26.9% of total revenue, up from 23.4% in Q4 of last year. As part of our restructuring, we are optimizing our go-to-market strategy to better support our Enterprise customers and drive additional productivity. G&A expense declined by 12% to $84 million, or approximately 7.5% of total revenue, down from 8.9% in Q4 of last year, as we focused on achieving greater efficiencies in our back office. Non-GAAP operating income was $405 million, exceeding the high end of our guidance of $326 million, as we took actions to reprioritize our investments in Q4. This translates to a 36.2% non-GAAP operating margin for Q4, as compared to 39.2% in Q4 of last year. Non-GAAP diluted earnings per share in Q4 was $1.22, 44 cents above the high end of our guidance. Due to our share repurchase program, our Q4 weighted average share count has decreased year-over-year by approximately 5 million shares to 301 million. Turning to the balance sheet, deferred revenue at the end of the period was $1.3 billion, up 11% year-over-year from $1.2 billion. This is above our guidance as we saw increased commitments from customers and extended contract durations. Looking at both our billed and unbilled contracts, our RPO totaled approximately $3.4 billion, up 30% year-over-year from $2.6 billion. We expect to recognize approximately 56% of the total RPO as revenue over the next 12 months, as compared to 63% in Q4 of last year. As a reminder, our annual seasonality of renewals is weighted towards the first half of the year. We expect Q1 deferred revenue to be up zero to 1% year-over-year, partially due to the strengthening of the dollar starting late in Q1 of FY23. Since then, the major currencies we do business in are down 5 to 10% vis-a-vis the dollar. We ended the quarter with approximately $5.4 billion in cash, cash equivalents, and marketable securities, excluding restricted cash. We had operating cash flow in the quarter of $212 million, up from $209 million in Q4 of last year. Free cash flow was $183 million, as compared to $189 million in Q4 of last year. Our margins for operating cash flow and free cash flow were 18.9% and 16.4%, respectively. Because Section 174 tax legislation requiring capitalization of R&D expenses was not repealed in FY23, we incurred an additional cash tax payment in Q4. Despite this payment, we still exceeded the high end of our previously provided range by $36 million, for a full year total of $1.186 billion. For FY24, we expect free cash flow to be in the range of $1.2 to $1.25 billion. Now, turning to guidance. For the first quarter of FY24, we expect revenue to be in the range of $1.08 to $1.085 billion, which at the midpoint would represent approximately 1% year-over-year growth, or 2% in constant currency. We expect non-GAAP operating income to be in the range of $374 to $379 million. Our outlook for non-GAAP earnings per share is $0.96 to $0.98, based on approximately 304 million shares outstanding. This outlook reflects the three fewer days in Q1 versus all other quarters. For the full year of FY24, we expect revenue to be in the range of $4.435 to $4.455 billion, which at the midpoint represents approximately 1% year-over-year growth, or 2% in constant currency. We expect our non-GAAP operating income to be in the range of $1.606 to $1.626 billion, representing a non-GAAP operating margin of approximately 36%. Our tax rate is expected to approximate the blended U.S. federal and state rate. Our outlook for non-GAAP earnings per share is $4.11 to $4.18, based on approximately 309 million shares outstanding. Zoom is dedicated to maintaining a careful balance between growth and profitability. We remain committed to innovating our platform, optimizing our go-to-market motions, and evolving our culture to meet the dynamic needs of the market. We are confident that our continued investment in innovation will enable us to provide even greater value to our customers while also positioning us for sustained growth. Thank you to the Zoom employees, our customers, our community, and our investors. Kelsey, please queue up our first question.

Yes, thank you. As I mentioned in the prepared remarks, we started really focusing on driving efficiencies across the business in Q4. As you saw in the results, this came from looking across all third-party spend. And then as we moved into Q1, of course, the reduction. So it's really a combination of that, as well as looking across all of our business processes, including go-to-market where a restructuring is happening, to really focus the resources on our Enterprise customers and be as efficient as we can in our commercial and small business teams.

Thank you, Michael. I don't think there is any argument against deploying our cash, certainly to continue to advance our technology, advance our customer base. And as I said, we are constantly looking for opportunities. And as I've mentioned in the past, we have kind of three main criteria that we look at. We look at the technology; we want to make sure that we would be providing our customers something that works as well as the core of Zoom does today, the core Zoom platform. We look at the culture to make sure that the organizations could come together very well. As you know, we take culture so seriously here, and Eric and the whole executive team have spent a long time focusing on building that. And then, last but certainly not least, is valuation. And that has been tricky in the past. We've seen great assets that we loved but just couldn't get there, as unfortunately all of you know. And so we now see that becoming easier and easier. So I will tell you that Sanjay and his team have been very busy continuing to look for targets for us, and it certainly is a part of our strategy that we're considering for FY24.

We're not going to get into the specifics around the reduction. I will tell you it was pretty consistently applied across the company, the 15% that Eric mentioned, across the organizations as well as us and some of our other locations outside of the U.S. So you can take that into consideration as you're calculating what you think the savings are.

I guess I don't know that I would say... I mean, remember, on the Q3 call, we weren't specifically giving guidance; we were trying to help give a little bit of visibility, but we were still right in the midst of doing our FY24 planning. So as you know, we continued to work on that with all of the go-to-market teams, and also we made this decision around the team and the reduction. Putting all of that together came up with what we've now guided to. We do continue to see headwinds that we spoke about. Of course, currency is still a challenge, and we're going to see some year-over-year impact in Q1 because the dollar really started to strengthen in the back half of Q1 last year. So you should expect to see some year-over-year impact there, as well as just these changes in the go-to-market team right now, making sure that we get everybody lined up and looking at where that is. All of that was considered as we set the FY24 guidance.

We have announced a price increase for our online customers that will be effective, I believe the date is March 1st, as we announced earlier this month. And we believe that reflects, and that's only for monthly customers, not for annual customers. And we believe that starts to reflect the value, as you said, that we have created for our customers over the last few years. It's been many years, it predates me, since the last time there was a price increase. And then on the Enterprise side, we did a pricing update, all-inclusive with Zoom One, the bundle that we came up with last year. And we believe that really reflects the best way for our customers to buy and get full value out of the platform. And that considers all of the products that are included at what we feel is an appropriate price point at this time.

Yeah, that's right. Thank you.

You know, Tyler, we're always focused on being as efficient as possible in our gross margins. You've seen we said we expect to be 79.5% for next year, which is right on top of our long-term target margins. In terms of our operating margins, we want to always watch for opportunities for investment in top-line growth, if that's really what we are driving for. So we will continue to make these decisions and watch for opportunities throughout the year. If we see opportunities to invest in go-to-market, maybe channel programs, anything that we can do to drive top-line growth, that would be our first priority. But as we said in the prepared remarks, we're going to balance that with profitability. So we're certainly committed to the guidance that we set. I don't think we're committing to expanding beyond that today, as again our first priority is continuing to accelerate through go-to-market efficiencies as well as expand our product portfolio.

So in terms of the expectations for online this year, they are consistent with what we've been saying for the last couple of quarters, which we expected to stabilize during mid next year from a dollar amount, meaning starting to see it continue to decline quarter over quarter from a dollar perspective for the last probably five or six quarters, and we get kind of like Q2 to Q3 of next year we expect to see that start to stabilize, which is great when you look at all the initiatives that are in place. And then I'm sorry, the last part of your question about renewals was about...

Yes, so renewals are always an opportunity to talk to our enterprise customers around Zoom One, the platform bundle, which we think is a great opportunity for our enterprise customers to help our prospects and customers understand the full features of the platform. And then of course there is a natural opportunity to do that as they're going through the renewals period. And as we guided, we expect renewals to be strong in Q1. However, there is going to be that impact of currency that we've already experienced for Q2 through Q4, but unfortunately we have one more quarter against the previous year comps that there's going to be some impact and headwinds there.

Yeah, this fiscal year, yes. I just want to make sure people didn't think fiscal '25.

You're welcome.

So we expect renewals. We talked about renewals over the last year, the last 12 months, and we expect them to continue at kind of the same rate. And what we've mentioned in the past is that we have seen some contraction in seats as organizations around the world are experiencing reductions, so working with them on that. But on the other side, the opportunity to really bring a lot of value to our customers through our total cost of ownership, which includes expansion of the total portfolio. So as you saw, phone really resonating very well, especially in this economy, and contact center, while it's still small from an absolute dollars perspective, it doubled the ARR for contact center from Q3 to Q4. So again, small relative dollars, but really exciting to see it coming into its own. And we expect that to continue to contribute through all of this year, but then really start to accelerate from a contribution perspective in FY '25. And I do mean FY '25 in that comment. And then of course there's Zoom IQ for sales as well, which is on a similar trajectory in terms of contact center, that small dollar contribution, but accelerating in terms of its overall growth.

I think what's amazing and really interesting about Zoom One is it's not just new customers that are buying the Zoom One bundle, it's existing customers as well that are upgrading. And as a reminder, it includes Zoom meetings, but also Zoom phone, it includes team chat and whiteboard. So really starting to see customers embracing the full effects of the platform. We have a Fortune 10 customer now that is a long-standing customer of ours that moved on to the Zoom One bundle and has standardized on Zoom Team Chat, which we're super excited to see. So that's an example of what starts to happen when these customers are really exposed to the full value of the platform that we can bring to them. And I don't know exactly the percentage of how it broke out in Q3, Q4, but it is really starting to take the lead in terms of how our enterprise sales teams are selling.

Sure. So one thing to remember, Kash, is that while we are expecting the online portion of the business to stabilize from a dollar perspective during the year, it is still down year over year because of what happened in FY '23, where the dollar amounts were much higher in those earlier quarters as it came down. So we still have the unfortunate impact of the online segment of the business tamping down the growth of the enterprise business. And so that's what you're seeing reflected there. And so the stabilization that occurs this year will really help as we look forward to next year, which we've always said is sort of re-acceleration, but back half of this year into FY '25. And that's what we see in our internal models today.

Well, there's the combination of first of all, online is still down year over year, and so you're not going to start to see the year-over-year stabilization of online until the back half of it. Even though the dollars are stabilizing, the year-over-year comparables are still down until the very back half of this year. And then while we've seen all the strength we've talked about in Zoom One and Zoom Phone, part of the expected growth is coming from these other newer products that are still early in their trajectory. But if you remember and think about how where Zoom Phone was in its second year of life, that's where Zoom Contact Center and Zoom IQ for sales are now. And you see Zoom Phone, which is about to turn four, how it's really contributing. So we've just got a little time ahead to get those products maturing and really contributing.

So remember, for Q1 there is the definite impact of being three fewer days, which has real impact as compared to three fewer days of revenue, as well as the impact of currency which we didn't have last year. So that year-over-year impact is going to definitely be visible in Q1 of FY '24. And then we continue to see in the enterprise elongated sales cycles, deal scrutiny. I was sort of laughing with a fellow CFO saying this is the year of the CFO because I have gotten invited to speak at more sales kickoffs this year than you can imagine because every sales team is having to learn how to sell to the CFO, including ours. And that is exactly the experience that we're having. And so it just means they're taking a little bit longer and everybody's being very thoughtful about their purchases. And so all of that was taken into consideration as we set our full year guidance.

I definitely think there is a question as to the state of the economy and when it comes to investments. While we think we are incredibly well positioned with our total cost of ownership and the value that we bring to our customers, everybody is being very cautious until there's better visibility about the potential of a recession or not and where we're going to come through this. And we expect that could impact us at least through the rest of this year.

It really depends on the customer. The thing that I would point out though is it's not just the uplift in the dollar amounts, it's the retention that we see, which is really important to us. Customers that have more... remember at Analyst Day we showed that chart that more than 50% improved retention rates when they have more than one product deployed. And so the value of us having a broader platform in there, including the ones that are much more retentive like Zoom Chat and Zoom Phone, really brings a lot of value to us.

I think you're likely to see it be slightly under, but what we're getting back to, which was very disrupted last year, is a more normalized relationship between those two as we're on more of a normal course now from a cash tax perspective.

In terms of when it's going to become 10%, it's sometime early this year in FY '24. And we are very excited about the momentum. We had 100% year-over-year growth in the product. And it's back to even in this economy. Especially in this economy, companies are looking for opportunities to standardize on one vendor and also because there is a lot of value to be gained by getting rid of those on-prem servers as well as the very disruptive price point that we have all the way around. It's just proving to be very attractive. And as Eric mentioned, there's still a lot of opportunity in the market available, so we expect that to continue. And I don't know what to expect to do, but as a reminder, Q2 and Q4 tend to be our really peak quarters in terms of Zoom Phone adds. So while we had an amazing number of additions in Q4, I don't expect that to be the new bar. We expect to be seasonally down in Q1, but still very excited that the momentum continues to be up and to the right.

In terms of M&A, we look at both. We've been very successful by buying those technology tuck-ins to accelerate our development, as you've seen with the Solvvy acquisition, which has been a great accelerant for us in terms of contact center. And we continue to look at those, but also looking at other areas where there might be leaders in the space that make sense for us. So we're continuing to look at both. And every quarter we talk to our board about our capital allocation strategy, and of course M&A is at the top of the list. We do not, as you indicated, have a buyback authorization in place today. We will continue to look for opportunities to deploy our capital in the best way possible for our investors. And right now, as I said earlier, our number one focus is re-accelerating top-line growth and making sure that we have the flexibility to do that if opportunities arise. And so that's why for the moment we've decided to hold at least on requesting an authorization for a buyback.